What this lesson teaches
I can define money supply and monetary policy.
Syllabus K343, 4.3.1. Definitions of money supply and monetary policy
Make a guess
The central bank raises interest rates. Is this fiscal policy or monetary policy?
- Monetary policy, because it changes the cost of borrowing.
- Fiscal policy, because it affects how much people spend.
- Neither, because interest rates are set by banks alone.
Show the answer
Monetary policy, because it changes the cost of borrowing.
Monetary policy uses interest rates, the money supply and the exchange rate. Fiscal policy uses taxes and government spending.
The money supply is the total money in the economy; monetary policy changes interest rates, money supply or the exchange rate.
The money supply is the total amount of money in an economy. It includes notes and coins, and money held in bank accounts.
Monetary policy is the use of interest rates, the money supply and the exchange rate to steer the economy. The central bank usually runs it.
Monetary policy changes how much households and firms spend. When money is cheap to borrow and easy to get, people tend to spend more. When it is dear or hard to get, they tend to spend less.
Do not mix it up with fiscal policy. Fiscal policy uses taxes and government spending, and the government decides it. Monetary policy uses money and interest rates, and the central bank usually decides it.
- Money supply
- Total money in the economy: cash plus bank deposits.
- Monetary policy
- Using interest rates, money supply and the exchange rate to influence the economy.
- Run by
- Usually the central bank.
Worked example: Fiscal or monetary?
Sort each measure into fiscal or monetary policy.
- The central bank raises interest rates: monetary.
- The government cuts income tax: fiscal.
- The central bank lets the currency rise in value: monetary.
- The government builds more hospitals: fiscal.
Watch out for this
Monetary policy means the government printing more money to pay for its spending.
Monetary policy is about managing interest rates, the money supply and the exchange rate to steer the economy, not funding government spending.
Check your understanding
Which of these is a monetary policy measure?
- Lowering interest rates
- Raising the rate of GST
- Spending more on schools
Show the answer
Lowering interest rates
Right. Interest rates are a monetary tool.
Check your understanding
Which body usually carries out monetary policy?
- The finance ministry, through the budget
- The stock exchange
- Commercial banks, acting together
- The central bank
Show the answer
The central bank
Right. The central bank sets interest rates, manages the money supply or steers the exchange rate.